Question

Q2. Expect that stock in Alpha Air Freight has a beta of 1.2. The market risk premium is 7 percent, and the risk-free rate is 6 percent. Alpha's last dividend was $2 per share, and the dividend is expected to grow at 8 percent indefinitely. a. The stock currently sells for $30. Analyze how it will be Alpha's cost of equity capital.

Answer 1

Calculation of Cost of Equity capital of Alpha Air Freight :

Formula used in Capital asset pricing model (CAPM) is

Cost of Equity capital = Risk free rate + [ Beta * ( Market Risk Premium - Risk free rate)]

Given,

Beta = 1.2

Market risk premium = 7%

Risk free rate = 6%

Dividend per share = $2

Expected growth rate of dividend = 8%

Market price per share = $30

Cost of equity capital = 6% + [ 1.2 * ( 7% - 6%)] (by using above formula)

= 6+1.2

= 7.2

Calculation of Cost of Equity by using Dividend Discount Model :

Cost of equity capital = (Dividend per share for next year / Current year market price of share ) + Growth rate of dividend

Dividend per share in next year = Dividend in current period * (1 + Growth rate)

= 2 * ( 1+ 8%)

= 2.16

   Cost of Equity Capital = (2.16 /30) + 8% (by using above formula)

= 15.2